Thursday, December 27, 2007

The WSJ (sub only, I'm afraid) had a piece yesterday on a process it never actually names--the "short refi" (related to the "short sale"). What makes these short refis--refinance transactions where the new loan is less than the balance due on the old loan, with the old lender agreeing to call the loan paid in full and write off the difference--so unusual is that the old loans are nasty high-rate subprime loans to old people, and the new loans are reverse mortgages.

The strategy worked recently for Gloria Forts, a 62-year-old retired federal worker in Forest Park, Ga., a suburb of Atlanta. After refinancing her home in August 2006 with a $106,500 mortgage from Fremont Investment & Loan in Brea, Calif., Ms. Forts was facing monthly payments of $950.41. That consumed 70% of her monthly income from Social Security and a pension. Intending to start a new job, she found herself kept at home by diabetes complications and back surgery. In June, she sought help from the Atlanta Legal Aid Society.

There, she found William J. Brennan Jr., a veteran housing attorney who, over the past 18 months, has developed a sophisticated model for settling subprime debts with reverse mortgages. After Ms. Forts received a foreclosure warning in October, Mr. Brennan connected her with Genie McGee, a reverse-mortgage specialist with Financial Freedom Senior Funding Corp., an Irvine, Calif., unit of IndyMac Bancorp Inc. She determined that Ms. Forts would qualify for a reverse mortgage of about $61,000.

Mr. Brennan sent Fremont's loss-mitigation department a letter proposing that the company agree to take that sum and cancel its plans to foreclose on the house. On Dec. 3, the day before the foreclosure sale was supposed to take place, Fremont agreed to the deal and stopped the foreclosure.

Using a reverse mortgage as a foreclosure workout is certainly unusual. I've written about reverse mortgages here if you're not familiar with the beast. They were designed for older borrowers (the minimum age is 62 for all products I know about) who are house-rich but cash-poor. Using them for borrowers who are house-poor, to prevent foreclosure, isn't exactly what they were intended for. And using them to "create" an equity cushion that they can then absorb in deferred interest is quite the innovation. (Of course the "equity" here isn't being "created"; it's being "donated" by the old lender.)

Then again, it isn't every historical moment in which lenders are willing to accept 57 cents on the dollar on a short refi, either. The key to the reverse mortgage is that the maximum loan amounts are much lower, on the whole, than they are for forward mortgages. (Because the amount that can be borrowed is a function of both the value of the home and the age--the likely remaining lifespan--of the borrower, only the very very old can borrow as much with a reverse mortgage as with a forward mortgage.) The WSJ doesn't give the current appraised value of Ms. Forts' property, but I'd guess that the original LTV of the new $61,000 reverse mortgage is not much more than 50% (suggesting that the old $106,500 mortgage, which apparently carried an interest rate of 10% or so, was around 90% of current value). It says a lot about Fremont's estimate of loss severity that they took the money and ran.

Is this a good deal for Ms. Forts? Well, she gets to stay in her house. (She might describe this as getting to "keep" her house, but the way a maximum-balance reverse mortgage to a 62-year-old borrower is likely to work, statistically, what she just did, in effect, was give the deed to IndyMac while reserving a life estate.) She is highly unlikely ever to be able to withdraw cash again from it; at her age and that loan balance, my guess is that compounding interest on the original balance will far outstrip any possible positive appreciation on that property in Ms. Forts' lifetime, and her heirs will simply hand over the deed to the bank.

What I find mildly amusing is that the WSJ reporter almost, but not quite, gets the issue here:

With a reverse mortgage, the bank makes payments to the homeowner instead of the homeowner making payments to a bank. The loan is repaid, with interest, when the borrower sells the house, moves out permanently or dies. The products are complex and have high fees -- typically about 7% of the home's value -- and they make it difficult for homeowners to leave the property to their heirs. But they may be the best option for people who have built up equity in their home and would otherwise lose it.

Actually, a reverse mortgage doesn't make probate any harder than a forward mortgage does. It's not that it's "difficult" to leave the property to the heirs; it's that the loan amount is likely to be equal to or more than the property's value at that point. Notice the odd phrasing of that last sentence: grammatically, "it" probably refers to "equity," but that of course is going to be lost in all cases (except for borrowers unfortunate enough to die prematurely; one hopes that doesn't make the heirs happy). The only thing a reverse mortgage borrower "keeps," in practical terms, is occupancy.

This is also curious:

The transaction illustrates one of the biggest challenges in getting lenders to accept payouts from reverse mortgages: taking less money than the house may be worth.

My sense is that the WSJ reporter just can't really wrap her mind around the reality of the mortgage and housing markets today. This business of "taking less money than the house may be worth" (as opposed to "taking less than the loan amount") may just be sloppy phraseology, but I think it's kind of sypmtomatic of how hard it really is for some folks to shed the assumptions of the Boom. Short refis are going on all around us, not just with reverse mortgages: a lot of the loans going into FHASecure, for instance, are short (by the amount of some or all of a second lien, often, but in some cases even the first lien payoff is short). I'm surprised that you still have to say this out loud to people, but what "the house is worth" is no longer a particularly relevant concern for a lot of people. The issue is what you owe, and as long as there are places in the world where expected loss severity to lenders can be in the neighborhood of 47% of the loan amount, you probably owe too much.